Could you be more diversified? Alternative investments may improve your portfolio.

It’s often said that concentration is the key to building wealth, and diversification is the key to maintaining it. Accordingly, many investors do a good job of diversifying their holdings of stocks and bonds. This is a wise choice.

However, many of these same investors could go further in improving their portfolios through alternative investments, which we will define as anything that is not a stock, bond or cash. Let’s take a look at two of the alternative options we typically explore with clients.

Private Real Estate

Real estate presents numerous paths for investment. Most people are familiar with real estate investments in rental properties or publicly traded Real Estate Investment Trusts (REITs). However, investors can also find interesting opportunities in commercial real estate via limited partnerships and private REITs.  

Similar to bonds, commercial real estate can provide a steady stream of income as rental income is passed through to investors. In contrast to bonds, increasing rents potentially can lead to principal appreciation that should offset the effects of inflation.

Here’s another way to put it. If inflation is 2 percent, a fixed-rate bond with a 3 percent nominal yield would have a 1 percent real return. But a real estate fund with a 4 percent yield earns a 4 percent real return if it can appreciate in line with inflation. Adding exposure to this differentiated asset class can improve a portfolio’s expected risk/return profile. 

Private Equity

For investors seeking capital appreciation, public stocks have been and should continue to be the primary tool for long-term growth. That said, private equity investments could augment an investor’s portfolio.

Private equity strategies come in many forms, but for our purposes, let’s focus on middle-market buyout funds. The managers of these funds (sometimes called sponsors) seek to build a concentrated portfolio of small or middle-market companies that they can sell later for a profit. 

In aggregate, private equity generally has produced higher returns than the public stock market over the past 30 years that the industry has existed. Because of these outsized returns, private equity firms have grown considerably and are now aggressively raising capital from individual investors.

We believe that a targeted allocation to private equity can augment the appreciation potential of many investors’ portfolios. However, great care should be taken to size these investments correctly, because most private equity investments aren’t liquid and require capital to be committed for periods of seven to 12 years. 

Even investors who believe they are adequately diversified can benefit from taking a second look at their portfolios. Exploring alternatives to the standard investments can provide additional peace of mind and the potential for greater returns.

Nathan Kurita is a managing director for Pinnacle Wealth Advisors and can be reached at Nathan.Kurita@pnfp.com.